If you’re an accountant or investor, you’re probably familiar with the terms gross sales and net sales. But for business owners mainly, it’s essential to understand the difference between these terms.
Gross revenue and net sales are generally used to reflect the financial performance of an organization. They are calculated for a specific period, giving a complete analysis of a business’s sales during that time. For business owners, comparing gross sales vs net sales is helpful to formulate sales strategies that improve revenue.
What is ‘Gross Sales’?
‘Gross sales’ is the sum of all sales reported in a period without any deductions. Simply put, it’s the total revenue a company receives in any form.
What is ‘Net Sales’?
‘Net sales’ is defined as gross sales minus allowance, discounts, and returns. As a result, the net sales revenue amount is typically lower than gross sales.
- Returns by the customer during the period of calculation
- Discount offered to the customer against the sale of the product
- Allowances related to the missing, damaged, or stolen products
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An early payment discount, such as paying 5% less if the buyer pays within ten days of the invoice date. The seller does not know which customers will take the discount at the time of sale, so the deal is typically applied upon receiving payment from the customers.
Reductions in the price paid by a customer due to minor product defects. The seller offers a sales allowance after the buyer has purchased the items in question.
A refund is granted to customers if they return goods to the company (typically under a return merchandise authorization).
Difference between Gross Sales vs Net Sales –
Here are the key differences:
Calculation of Gross vs Net Sales
To arrive at gross sales, the total units sold are multiplied by the selling price for each unit. To arrive at net sales, deductions are subtracted from Gross sales.
The company’s gross revenue is calculated without considering the returns, discounts, and allowances related to those sales. On the other hand, net sales are calculated after accounting for the above, i.e.,
Gross sales are the total sales without deductions, while net sales are the total sales after deductions from the gross sales. Let’s take a look at the example below to understand this better.
During the financial year, a company sold 150,000 product units for $10 each. Out of these units, goods worth $200,000 were damaged. $100,000 were returned by the customers. And $250,000 was given as a discount to other customers. The gross sales value will be calculated by multiplying the number of units sold by the price at which the units are sold. So, in this case, gross sales will be 150,000 * $10, which amounts to $1,500,000.
On the other hand, the net sales formula is calculated by subtracting returns, discounts, and allowances related to the sales from the value of gross sales. As a result, the value of net sales will be $1,500,000 – $200,000 – $100,000 – $250,000 which amounts to $950,000.
The gross sales value will always be higher than or equal to a company’s net sales during the same period. It’s because net income is derived after subtracting the returns, discounts, and allowances from gross income.
Net income is always dependent on gross sales. If you’re wondering how to calculate net sales, coming up with a figure for gross revenue is the first step. Once the number for gross sales is arrived at, deductions are adjusted against it. The resulting amount is net sales.
On the other hand, the value of total units sold during the given period multiplied by the per-unit price gives gross revenue. Net sales are nowhere a part of it. Thus, gross revenue is independent of net income.
The value of net sales of a company during the specified period is reported in the income statement. On the contrary, the value of gross sales is not written in any of the financial statements.
After looking at a financial statement, if you’re wondering how to calculate gross sales, you have to go through the notes in detail. Once you find more information on the net sales activities of the company, you can figure the gross sales during the period.
The net sales formula is much more relevant in decision-making than gross sales. It gives a more holistic picture of a company’s current financial position.
Net sales aid the management and shareholders in setting objectives and making strategic decisions for the company. However, because gross sales aren’t reported in financial statements, they hold little value for coming up with actionable insights.
On comparing gross sales vs net sales, it’s seen that operational expenses of the business are deducted from gross revenue. Consequently, it gives a better interpretation for investors when looking at net sales. Operational expenses include rent, insurance, shipping and freight charges, payroll, and more.
After deducting the operational expenses from gross sales, non-operational expenses are subtracted from net income. Net sales are, thus, representative of the profit arrived at after deducting all costs.
Gross Sales vs Net Sales: At a glance
Below is a summary of all the points we discussed in the previous section.
|Features||Gross Sales||Net Sales|
|Meaning||The total value of sales made by the company during a given period. Costs related to such sales aren’t adjusted.||The total value of sales made by the company during a given period. It’s gross sales minus the returns, discounts, and allowances related to those sales.|
|Formula||Number of units sold * Rate per Unit = Gross Sales||Gross sales – Returns – Discount – Allowances = Net Sales|
|Dependency||They’re independent of net sales.||They depend on gross sales.|
|Decision-Making||They’re generally not relevant to the decision-making process.||They’re relevant and essential for making strategic decisions.|
|Profit & Loss Account||This figure is not reported in the Profit and Loss account.||Net sales revenue is always reported in the Profit and Loss account.|
|Calculation||The sales return, discount, and allowance amounts are ignored when calculating the gross sales figure.||Here’s how to calculate net sales. First, consider the sales returns, discounts, and allowances and then deduct them from the gross sales|
|Order of Calculation||The gross sales amount is always calculated before net income.||Net sales are naturally calculated after gross revenue.|
|Total Amount||The gross revenue figure will be either higher or equal compared to the net sales figure of an entity.||The net sales formula clearly shows that net income figures will always be lower than or equal to an entity’s gross sales figure.|
|Expenses||Expenses related to daily operations like rent, insurance, utilities, and more are deducted.||Non-operational expenses like allowances, discounts, and returns are deducted.|
|Accuracy||Calculating gross sales figures does not portray an accurate picture of the actual sales made by an organization because discounts, returns and allowances aren’t considered.||The net sales figure reflects an accurate picture of the sales made by an organization because it includes the above deductions.|
What can you learn from Net Sales vs Gross Sales?
Gross sales are not a remarkably accurate measure of a business’s financial health. If you look at gross revenue – without looking at the rest of an income statement – you may conclude that a company’s sales numbers are poorly overestimated.
Net sales are the most accurate and effective reflection of a business’s sales operations. Deductions are essential in understanding how well a company is selling its product or service. If you don’t consider them, you ignore the different strategies employed by your sales team to achieve a specific sales figure. As a result, you miss out on opportunities to rectify errors or scale the business.
The difference between gross sales and net sales is also a valuable indicator of a business’s product quality. If the difference between the two digits is substantial or steadily increasing, there may be some issues or shortcomings with the product. It could result in significant returns or discounts and, subsequently, losses.
Gross and net sales are important metrics to understand, both with and independent of each other. If you’re trying to figure out ways to change your sales approaches and efforts or improve the quality of products, you’ll need to consider these figures.
Gross Sales vs Net Sales for business
Accountants and investors may be more familiar with gross sales and net sales. But as a business owner, knowing what they mean can give you strong indications of financial performance. These figures also help identify potential issues before they snowball into serious problems.
By understanding what net sales vs gross sales is and tracking changes in their figures over time, you can identify what’s holding your sales back. You can then review processes to improve the sales process and, ultimately, business revenue.